LIVEPERSON INC

Income Taxes

Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences are expected to become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. The Company includes interest accrued on the underpayment of income taxes in interest expense and penalties, if any, related to unrecognized tax benefits in general and administrative expenses. The Company recorded a valuation allowance against its U.S. and Australia deferred tax asset as it considered its cumulative loss in recent years as a significant piece of negative evidence. Since valuation allowances are evaluated on a jurisdiction by jurisdiction basis, we believe that the deferred tax assets related to LivePerson UK, Engage, Kasamba Israel and LivePerson LTD Israel are “more likely than not” to be realized as these jurisdictions have positive cumulative pre-tax book income after adjusting for permanent and onetime items. During the year ended December 31, 2017, there was a reduction in the valuation recorded of $4.6 million.

Under Section 382 of the Internal Revenue Code of 1986, as amended, the Company’s use of its federal net operating loss (“NOL”) carryforwards may be limited if the Company experiences an ownership change, as defined in Section 382. Such an annual limitation could result in the expiration of the net operating loss carryforwards before utilization. As of December 31, 2017, the Company had approximately $32.8 million of federal NOL carryforwards available to offset future taxable income. Included in this amount is $5.1 million of federal NOL carryovers from the Company’s acquisition of Proficient. These carryforwards expire in various years through 2027.

The domestic and foreign components of (loss) income before provision for income taxes consist of the following (amounts in thousands):



	Year Ended December 31,
	2017			2016			2015
United States	$	(25,585	)	$	(40,774	)	$	(16,362	)
Israel	3,458			15,622			2,257
United Kingdom	2,087			2,345			1,564
Netherlands	1,568			3,104			1,919
Australia	(1,979		)	(2,774		)	(565		)
Germany	2,424			2,085			327
Other ⁽¹⁾	337			453			230
	$	(17,690	)	$	(19,939	)	$	(10,630	)
⁽¹⁾ Includes Japan, Italy, Singapore, Canada, and France

No additional provision has been made for U.S. income taxes on the undistributed earnings of its Israeli subsidiary, LivePerson Ltd. (formerly HumanClick Ltd.), as such earnings have been taxed in the U.S. and accumulated earnings of the Company’s other foreign subsidiaries are immaterial through December 31, 2017.

The provision for income taxes consists of the following (amounts in thousands):



	Year Ended December 31,
	2017			2016		2015
Current income taxes:
U.S. Federal	$	—		$	1,829	$	(524	)
State and local	47			27		309
Foreign	2,852			2,226		1,573
Total current income taxes	2,899			4,082		1,358

Deferred income taxes:
U.S. Federal	(1,289		)	841		13,791
State and local	(1,144		)	99		876
Foreign	35			912		(211		)
Total deferred income taxes	(2,398		)	1,852		14,456
Total provision for income taxes	$	501		$	5,934	$	15,814

The difference between the total income taxes computed at the federal statutory rate and the provision for income taxes consists of the following:



	Year Ended December 31,
	2017		2016		2015
Federal Statutory Rate	34.00	%	34.00	%	34.00	%
State taxes, net of federal benefit	4.09	%	3.24	%	0.35	%
Non-deductible expenses – ISO	(0.78	)%	(1.85	)%	(8.57	)%
Non-deductible expenses – Other	(1.19	)%	(0.88	)%	(2.20	)%
Foreign tax rate differential	(1.97	)%	0.89	%	(12.41	)%
Change in valuation allowance	26.12	%	(53.55	)%	(148.24	)%
Return to provision true-up adjustment	—	%	(9.22	)%	—	%
Effect of new tax legislation	(56.84	)%	—	%	—	%
Other	(6.26	)%	(2.42	)%	(11.15	)%
Total provision for income taxes	(2.83	)%	(29.79	)%	(148.22	)%

The effects of temporary differences and tax loss carryforwards that give rise to significant portions of federal deferred tax assets and deferred tax liabilities at December 31, 2017 and 2016 are presented below (amounts in thousands):



	Year Ended December 31,
	2017			2016
Deferred tax assets:
Net operating loss carryforwards	$	8,093		$	6,186
Accounts payable and accrued expenses	4,429			4,906
Non-cash compensation	9,510			12,541
Intangibles amortization	5,513			6,151
Allowance for doubtful accounts	232			447
Intangibles related to acquisitions	—			118
Total deferred tax assets	27,777			30,349
Less valuation allowance	(23,260		)	(27,881		)
Deferred tax assets, net of valuation allowance	4,517			2,468
Deferred tax liabilities:
Property and equipment	(2,010		)	(1,695		)
Goodwill amortization and contingent earn-out adjustments	(2,669		)	(3,332		)
Total deferred tax liabilities	(4,679		)	(5,027		)
Net deferred tax liabilities	$	(162	)	$	(2,559	)

ASC Topic 740-10 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with other provisions contained within this guidance. This topic prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate audit settlement. The Company had unrecognized tax benefits of $4.9 million and $4.2 million as of December 31, 2017 and 2016, respectively. Accrued interest and penalties included in our liability related to unrecognized tax benefits were immaterial at December 31, 2017 and 2016.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):



	Year Ended December 31,
	2017		2016
Unrecognized tax benefits balance at January 1	$	4,240	$	3,519
Gross increase for tax positions of prior years	—		200
Gross increase for tax positions of current years	684		700
Decrease due to expiration of statue	—		(179		)
Gross unrecognized tax benefits at December 31	$	4,924	$	4,240

The tax years subject to examination by major tax jurisdictions include the years 2011 and forward for U.S states and New York City, the years 2012 and forward for U.S. Federal, and the years 2012 and forward for certain foreign jurisdictions.

Tax Reform

In December 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act of 2017 (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code that affect fiscal 2017, including, but not limited to requiring a one-time repatriation tax on certain unrepatriated earnings of foreign subsidiaries that is payable over eight years (the "Repatriation Tax"). The Tax Act also establishes new tax laws that will affect 2018 and later years, including, but not limited to, a reduction of the U.S. federal corporate tax rate from 34% to 21%, a general elimination of U.S. federal income taxes on dividends from foreign subsidiaries and a new provision designed to tax global intangible low-taxed income ("GILTI").

In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. To the extent that a company’s accounting for certain income tax effects of those aspects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate to be included in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.

The legislation reduced the U.S. corporate tax rate from the current rate of 35% to 21% for tax years beginning after December 31, 2017. Under the Tax Act, our $32.8 million in federal net operating loss carryforwards generated as of December 31, 2017 will continue to be carried forward for 20 years and are expected to be available to fully offset taxable income earned in future tax years. Federal net operating losses generated after 2017 will be carried forward indefinitely, but generally may only offset up to 80% of taxable income earned in a tax year. In the quarter ending December 31, 2017, we revalued our deferred tax assets and liabilities due to these changes, including (a) revaluing our federal net deferred tax assets before valuation allowance using the 21% tax rate, resulting in a decreased federal deferred tax provision of $10.1 million; (b) revaluing our federal valuation allowance using the 21% tax rate, including the impact of tax planning strategies, resulting in a federal deferred tax benefit to continuing operations of $12.6 million; (c) recognizing a federal deferred tax benefit of $2.0 million for 80% of indefinite lived deferred tax liabilities, which are anticipated to be available as a source of taxable income upon reversal of deferred tax assets that would also have indefinite lives; and (d) recognizing $1.2 million state deferred tax provision unaffected by the changes in the Tax Act. The new legislation will require the Company to pay tax on the unremitted earnings of its foreign subsidiaries though December 31, 2017. Because of the complexities involved in determining the previously unremitted earnings and profits of all our foreign subsidiaries, the Company is still in the process of obtaining, preparing, and analyzing the required information. The Company estimates that the tax on unremitted earnings will be zero due to an overall accumulated deficit in earnings and profits.

The Tax Act creates a new requirement that certain income earned by a foreign subsidiary must be included in the income of the U.S. shareholder. This income (called Global Intangible Low-Taxed Income, or GILTI) is defined as the excess of a foreign subsidiaries income over a nominal return on fixed assets. The Company expects to be subject to this inclusion in future years. Under U.S. GAAP, the Company is allowed to make an accounting policy choice of either accounting for the effects of the GILTI inclusion as a current period expense, when incurred, or factoring such amounts into the Company’s measurement of its deferred taxes. The Company has elected to treat the effects of this provision as a period cost, and therefore, has not considered the impacts of GILTI on its deferred tax liabilities at December 31, 2017.

The Company's consolidated financial statements do not provide for any related tax liability on amounts that may be repatriated from foreign operations as the Company intends for these earnings to be indefinitely reinvested in operations outside the U.S. Accordingly, no provision has been made for United States income taxes that may become payable if those undistributed earnings of foreign subsidiaries are paid as dividends. At December 31, 2017, the estimated amount of foreign earnings for which the Company has taken a permanently reinvested position is $14.5 million.